What Entrepreneurs Need to Know About...
December 05 / January 06
Volume 3 Number 6
This is the third of a series on helping the entrepreneur put his or her best foot forward during the process of securing funding. The articles are researched and written by Eric Billingsley.
You've developed and patented a technology, crafted a business plan, and spent more than a few of your own—€”—€“and family members'—€”dollars to fund a startup company. It's time to take the business to the next level and seek investment from an outside source.
But before you send out a business plan to any and everybody who might hold the title of "investor," it's important to do some research. The fact is there are a number of different types of investors who can serve your company at different stages.
Angel Investors
Angel investors are often a great place to start if you're seeking a seed round of funding. Angels are high- net-worth individuals and/or groups of individuals who provide capital in exchange for an equity stake in startups. They are different from institutional investors in that they're investing their own money versus having to achieve a high return on investment for an entire business or organization. This often allows them greater flexibility.
Statistically, angels fill the need of making small or seed investments in startups. However, there are an increasing number of angel groups capable of making larger, more sophisticated investments too. In addition to providing capital, angels are often seasoned business professionals and can provide you with counseling, guidance and resources for future financing.
Corporate Venturing/Strategic Partners
Many corporations make a point of investing in start-up companies. This can take the form of strictly providing your company with venture capital and/or providing services and resources that help grow your company and boost the goals of the larger company.
In the first case, corporate venture capital is invested with the intent of achieving a strictly financial return on investment. Investments are often made into companies within the same industry or those with high growth potential. Directly taking an equity stake in a growth company is appealing for corporations because it cuts out the middleman.
Another way corporations invest into startups is by forming strategic partnerships. A larger corporation may take your company under its wing because your technology is complimentary or "synergistic" with its own. In addition to cash, this may involve providing you with technical or management counseling, access to established channels of distribution, and marketing assistance, among other services. For this they would receive an equity position or an option to buy your company or the product.
Venture Capitalists
Venture capital firms are generally private partnerships or closely held corporations funded by private pension funds, endowment funds, foundations, corporations and others. In other words they're accountable for investing and achieving a high return for a large number of sophisticated entities. Over the past few years the majority of firms have invested relatively large sums of money into later-stage companies. However there are still a number of firms that specialize in seed and early stage funding.
The goal of the VC is to help grow your company. To accomplish this they require an equity percentage of the company. They seek to exit from the investment—€”meaning cash out—€”in approximately three to seven years. And they will often take a seat on your board of directors (sometimes with a controlling position) to assist in making critical business decisions and to protect their investment.
Venture investments generally fall into the following categories:
—€ seed stage —€” money provided often before a company has a market-ready product
—€ early stage —€” assistance bringing a product to market
—€ expansion stage —€” helping a company grow past a critical point
—€ later/mezzanine stage —€” helping a company grow to the point of attracting public financing through a stock offering.
Debt Financing
The most common form of debt financing is a business loan offered by banks, savings and loans, commercial finance companies and/or the U.S. Small Business Administration.
Financial institutions offer business loans at an agreed-upon interest rate for a specific period of time. As the recipient, you typically need to have some type of security to back up the loan in the case of default. The latter may include assets such as a home, other property, machinery in a factory, etc.
Depending on the nature and stage of development of your company, obtaining this type of capital can be a risky endeavor. For example, if you're a startup that's likely to burn through a million dollars in one year before generating revenue, securing the loan with your luxury house is probably not a smart move. On the other hand, if you are able to get a loan, paying interest will usually be cheaper in the long run than giving an equity position.
However, once the company and revenues are established, running a line of credit can be of assistance, but this is very different than getting cash to establish the company.
Investment Banking
These institutions or individuals create capital for a company through the process of issuing and selling debt and/or equity securities. They can also act as advisors for mergers and acquisitions. They are usually not applicable to early stage companies.
An example of an equity security is when you decide to raise capital by selling off partial ownership of the company to the public in the form of stocks —€”otherwise known as an initial public offering (IPO). The benefit of going public is that you can generate a huge sum of capital in a very short period of time. And the money raised during the IPO does not have to be repaid. The drawback is that you lose partial ownership of the company.
An example of a debt security is the corporate bond. These bonds are sold to investors with the idea of paying them interest over a certain period of time.
Approaching Investors
To save you and the investment community a lot of time and frustration, research prospective investors before sending a business plan. This is the best way to determine whether or not their practices are a fit for your business and funding needs. Angels and venture capitalists in particular tend to specialize in specific industries. It also helps to understand market trends, such as the industries/technologies receiving the highest percentage of investments.
There are a number of web sites that provide contact information for investors (see: Resources). Angels and venture capital firms typically outline their criteria for accepting business plans on their web sites.
Networking in the business community prior to contacting investors can also play in your favor. Many agree that your business has a better chance of landing capital when it's referred to investors from other successful entrepreneurs, venture capitalists, attorneys, accountants, bankers, business counselors or others who know the business and your credibility. And, it's quite possible that the average looking Joe that you've seen at a hundred business gatherings is the investor you've been looking for.
Resources:
National Association of Seed and Venture Funds
www.nasvf.org/
Angel Capital Association
www.angelcapitalassociation.org/
National Venture Capital Association
www.nvca.org/
MoneyTree Survey
Up-to-date statistics on venture capital investments
www.pwcmoneytree.com/moneytree/index.jsp
Inc Magazine
Articles about angel investors
www.inc.com/guides/finance/24011.html
Investorguide.com
www.investorguide.com/
Technology Ventures Corporation
Assistance to entrepreneurs
www.techventures.org
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